A lot of people wish there was a way to know which stocks will provide huge future returns – but what if there is already and most people just don’t know about it?Actually there is. Of course stock picking is an art not a science so you can never guarantee that you’ll get performance. But there are definitely some general principles which will help you identify stocks with the likelihood of performing well in the future. This relies on a combination of identifying what drives success and also looking at stocks which have historically performed excellently to know what to look for in the future.There are libraries full of well written books on this which would help give you this knowledge. But we’ve read them for you and share the highlights below.
Go for Great Companies Not Great Management
If you read the mainstream media you’ll often come across discussion of supposedly celebrity managers ascribed near mythical powers.It is true that some exceptional managers can lead companies to greatness. But in general, a focus on the individual not the company damages rather than improves share price over the long term.A company is the sum of its parts, so too strong a focus on a single individual distracts from good decision making. It also makes the company less likely to develop robustly independent of such executives. As legendary investor Warren Buffett says, you should invest in companies whose business and structure is so strong that it could survive even if run by idiots – because one day, it will be.That’s great advice, and the best performing stocks reflect strong companies not only strong leaders.
Go for Focus
Focus swings in and out of fashion for companies, which is why conglomerates rise and wane over the decades.The case for diversification is strong as a way of protecting earnings, but it is also less likely to lead to stellar results. Lack of focus means a company cannot benefit from its own synergies, and management time will be pulled in multiple directions. Many people in the business will have only a superficial understanding of large parts of it.If you look at companies that endure and thrive you’ll see that they define what they do and they stick to it with laser like focus for decades. This is one of Jim Collins’ core concept in his study of great companies, Good to Great. This does not mean that these companies are static, just that when they do new things those new things are well within the company’s core circle of competence. Think of Apple as an example – its discipline means it launches few products, allowing it to maximise returns without distraction on the ones where it knows it can do well.This laser focus translates into high profit margins, and great stock performance.
Pricing Power is Key to Stock Performance
You might not think there is such a thing as a license to print money – but the best performing stocks have the second best thing.That is a business model which allows them maximum pricing power. In other words, they are able to increase prices over the long term, feeding higher profits which in turn fuel great stock performance.Typically this pricing power comes from owning assets which make it difficult or impossible for competitors to eat the company’s lunch. This could be physical assets such as a utility system or transportation network which forms a natural monopoly. It could be intellectual property assets, such as long-term patents on a successful drug. It could be creative assets like a brand which allows the company to charge a premium for its products decade in and decade out.Coca Cola has been one of the best performing stocks over decades for exactly this reason – its unique formula, strong brand and distribution network combine to give it pricing power.
Financial Discipline is Critical
If you wanted a long term return, you wouldn’t entrust your life savings to a drunken sailor at the racetrack – and you shouldn’t do the same in the stock market, either.You may miss out on some stellar short term returns by not putting your money into companies with dubious financial methods. But in the long term, the best performing stocks always combine a high level of transparency with strong financial discipline.One of the reasons a disproportionate number of successful companies are headquartered in boring cities far from the most exciting destinations is because they have been built on traditional values of honesty, prudence and thrift. In the long-term that translates to a solid underpinning for a reliable, successful business.Choosing the best performing stocks is a lot easier than most people think. Strong performance shows itself over the long-term not just the short term flash in the pan pushed hard by financial hucksters. Like the pros, you should benefit from decades of accumulated wisdom about what leads stocks to great performance. Above we have outlined some key ways you can use that wisdom to identify stocks for your own portfolio. Why not run through the stock index now with those principles fresh in your mind?